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It’s Hard to Do Cost-Benefit Analysis When the Benefits Aren’t Quantified

September 20th, 2009 . by economistmom

BRITAIN SCOTLAND POLAR BEAR

Last Thursday, the Congressional Budget Office released a report on “The Economic Effects of Legislation to Reduce Greenhouse-Gas Emissions.” The report attempts to quantify the economic cost of the proposed policy changes–answering the (relatively narrow) question:  what would be the negative effect on GDP caused by higher prices of carbon-based energy?  The trouble is the report doesn’t attempt to quantify the benefits of the proposed legislation–so it’s not clear how useful this report will be to policymakers who should ideally at least implicitly be weighing social costs against social benefits in deciding whether policies are in fact worth pursuing.

In his blog, CBO director Doug Elmendorf summarizes their conclusions (emphasis added):

CBO concludes that the cap-and-trade provisions of H.R. 2454, the American Clean Energy and Security Act of 2009, would reduce GDP below what it would otherwise have been—by roughly ¼ to ¾ percent in 2020 and by between 1 and 3½ percent in 2050. By way of comparison, CBO projects that real (that is, inflation-adjusted) GDP will be roughly two and a half times as large in 2050 as it is today, so those changes would be comparatively modest. In the models that CBO reviewed, the long-run cost to households would be smaller than the changes in GDP because consumption falls by less than GDP and because households benefit from more time spent in nonmarket activities. Moreover, these measures of potential costs do not include any benefits of averting climate change.

In fact, the CBO report acknowledges (on pages 3-4) that they avoid the thorny issue of valuing the cost of climate change itself (and the benefit of avoiding climate change).  They explain (emphasis added):

Despite the wide variety of projected impacts of climate change over the course of the 21st century, published estimates of the economic costs of direct impacts in the United States tend to be small. Most of the economy involves activities that are not likely to be directly affected by changes in climate…

[A] relatively pessimistic estimate for the loss in projected real gross domestic product is about 3 percent for warming of about 7° Fahrenheit (F) by 2100. However, even for the levels of warming that have been examined, most of the estimates cover only a portion of the potential costs. Other costs in the United States could come from nonmarket impacts (which are not measured in GDP) and from the potential for abrupt changes…

They go on to explain that the “nonmarket impacts” of climate change:

are very difficult to evaluate in monetary terms because they do not directly involve products that are traded in markets. Although such difficulties apply to effects on human health and quality of life, they are particularly significant for biological impacts, such as loss of species’ habitat, biodiversity, and the various resources and processes that are supplied by natural ecosystems. Experts in such issues generally believe that those nonmarket impacts are much more likely to be negative than positive and could be large.

(Note the mention of this problem measuring “nonmarket” benefits as applicable to “effects on human health”–and hence the debate over health care reform–as well.  I’ve said before that the reasons to expand health care coverage shouldn’t be limited to “because it will save money”–even over the longer run.  Presumably we choose to “buy” things, and on net pay out money, for a reason.)

The CBO report also discusses the small possibility of a potential abrupt and catastrophic effect of climate change which could have large economic costs (as well as broader social costs) but (again) which economists don’t really know how to quantify given the tremendous scientific uncertainty:

Experts believe that there is a small possibility that even relatively modest warming could trigger abrupt and unforeseen effects during the 21st century that could result in large economic costs in the United States. Two examples of such possible effects are shifts in ocean currents that could change weather patterns and affect agriculture over large areas, and rapid disintegration of ice sheets, which could dramatically raise sea levels around the world. The sources and nature of such abrupt changes, their likelihood, and their potential impacts remain very poorly understood.

What I see as the trouble with CBO–known as the official “scorekeeper” for legislation being considered by Congress–doing a quantitative analysis of the “economic effects” of climate change policy, is that all their qualifying statements about their inability to quantify (in dollar terms) the main point of climate change policy (avoiding environmental damage and what that means for the broader well-being of our society) will be lost on the policymakers, and hence on the public as well.  People look for the numbers in a CBO report and will surely use the numbers about what’s bad about climate change policy as a reason not to enact that policy, as long as there are no concrete numbers to support the merits of the policy.  In other words, it’s hard for CBO to be the unbiased arbiter on policy evaluation if they’re only “tooled up” on one side of the debate.

That’s why the report released this week on alternative measures of well-being (getting beyond aggregate, market-based GDP in particular), commissioned by French President Sarkozy and written by Nobel laureates Joseph Stiglitz and Amartya Sen is particularly relevant and timely.  There’s a nice summary of the report’s findings on the International Political Economy Zone blog.  And here’s a link to a Bloomberg article on Stiglitz’s position, which contains this “money quote” (ironic pun intended):

“So many things that are important to individuals are not included in GDP,” said Stiglitz, a Columbia University professor.

How about that? Even very wise economists understand that well-being and true happiness go beyond things that have dollar signs in front of them.  ;)

5 Responses to “It’s Hard to Do Cost-Benefit Analysis When the Benefits Aren’t Quantified”

  1. comment number 1 by: Bill C

    I’m no scientist (only an economist), but it seems like we should be assigning a nonzero probability to the outcome “end of human life on earth”, and, if we place a value of “infinity” on avoiding that outcome, than the expected benefits of a policy which does so are also infinite!

    One thing economists need to try to communicate here is how modest the costs are, if the policy involves using price signals. Incentives work! Ironic (and sad) that so many politicians who claim to be believers in / defenders of the free enterprise system are the ones out there scaremongering over the costs. Its as if they fail completely to understand the best thing about capitalism - its flexibility and capability for adjustment and innovation.

  2. comment number 2 by: SteveinCH

    Bill C,

    I’m a business consultant and I’ll tell you the argument .0000001*infinity is still infinity is the equivalent of the business argument that says if I could just get 1% of the world’s population to buy my product 2 times a year, I’d make a killing.

    I don’t view myself as a scaremonger on any topic, although others on this site can always disagree, but let me ask you a few questions.

    1. Diane’s quotes refer to the long-term macroeconomic consequences. As I read the CBO report, there is also a $1500/year increase in energy costs to each US household. Using any definition of social welfare you like except the end of life on the planet, how would you rate the NPV of that $1500/year for the average household?

    2. As you consider your answer in 1, please consider only the likely effect of the US legislation on the total level of global greenhouse gas given that a) the impact of US greenhouse gas changes on global greenhouse gas emissions is likely to be small as a direct effect; b) the probability of the political process achieving the stated goal by 2050 is almost zero; c) I have yet to see a credible piece of research that offers a perspective on the timing and nature of small changes in global greenhouse gas emissions on global temperatures (but perhaps you have)

    3. Are you confident that the existing approach is a reasonably efficient way to achieve the goal of increasing the cost of carbon emissions? Early evidence (giving away all of the credits to connected interests) might make one think not.

    4. Do you understand the carbon cost versus innovation curve well enough to have a sense of how high to set the price of carbon? Do you believe policy makers in Washington do?

    There is no doubt that incentives work but there are many ways to offer incentives. Personally, I’m unconvinced that a US only regulatory regime that posits reductions in carbon that are on their face absurd (85 percent below current levels by 2050 is pretty much impossible without trillions in capital spending and some major innovation), is unlikely to be sustained, will have a marginal impact even if sustained and the net benefit cannot be measured with any confidence.

    In other words, neither of us can say with confidence what benefits will result (whether economic or not) from the proposed cap and trade legislation. Were I a betting man, I would bet on the benefits being very small for three reasons.

    1. I believe it is unlikely that China, India or other developing countries will make emissions reduction a priority in the next 10 to 20 years. Certainly their current behavior suggests they will not in the next 5 to 10.

    2. I very much doubt the US will achieve anywhere close to the targeted reductions in emissions. In fact, I will happily wager against the reductions being achieved. The US lacks the political will to sustain such an initiative at high cost to individuals for an ill defined future benefit.]

    3. Even if the US were to hit its targets, the impact on global emissions is likely to be small and the impact of that reduction is impossible to predict with confidence on the basis of current costs.

    Two final thoughts. First, the infinity times any number is infinity argument is more a matter of faith than of logic. Second, the bulk of the arguments that I have heard (and I admit there are many I have not heard) in favor of cap and trade offer no specific benefit for the cost that is clear.

    Thus, my conclusion is different than Diane’s. Doug Elmendorf didn’t comment on the noneconomic benefits for two reasons. One she cites, namely that they are hard to quantify, once an agreed upon temparature change has been identified. More importantly, it is hard to know what the impact of any change in greenhouse gas levels will have on the temperature over any period of time.

    The only thing we really know is that the Earth has gotten warmer over the last century (but not the last decade). According to the AGM theorists, economic growth should have been depressed in the last century because of rising temperatures (although I’ve never seen that argument made). If that isn’t true, then the Earth must just happen to be at its optimal temparature at this very minute. If that’s the argument, color me a skeptic. It’s far too convenient a perspective.

    Sorry for the long post but it’s a complicated subject with a lot of squishy thinking (including some of my own I’m sure)

  3. comment number 3 by: Jason Seligman

    What will our grandchildren say when we decribe tigers and polar bears to them, and explain that it really is better to have an extra 2-4 billion people in the world (living on less than 5 dollars a day) to make us things?

    What does it matter that you join the jet-set if there is nowhere left to travel to or to discover?

    Seems like it’s time to ration carbon.

  4. comment number 4 by: SteveinCH

    Jason,

    What does an extra 2-4 billion people in the world (living on less than $5/day) have to do with global warming? What threat is there to tigers (I’ve heard about poaching but not much else)?

    By the way, how do you propose to ration carbon on a global basis anyway?

  5. comment number 5 by: murf

    Jason: Our grandchildren will say “cool, I just saw them at the zoo yesterday, and if I want to I can go see them in the wild.”

    Oh, and in case you didn’t notice the rate of population growth is cratering with estimates that it will top out and 8 billion and decline from there.

    Global Warming = Typical climate variances we have seen in past history = much ado about nothing.